China Wrestles With Banks' Pleas for Cash

BEIJING—China's big banks are pressuring the central bank to free up funds to ease an unusual cash squeeze in the world's No. 2 economy, according to people familiar with the matter, illustrating a stark choice facing Beijing as it grapples with weaknesses in its financial system: add money to its system to help its lenders, or stay the course to rein in a rapid expansion of credit.

The Chinese interbank funding market has seen rates soar since early this month amid slowing foreign-capital inflows and banks' needs to fulfill investor obligations, among other factors. The squeeze is pushing up banks' funding costs and could impede a key source of funds for growth even as the economy slows.

ENLARGE

In a further sign of tighter conditions, Agricultural Development Bank of China, a state-controlled policy bank, on Monday reduced by a third the size of its planned 26 billion yuan ($4.2 billion) bond offering. The Ministry of Finance, in a rare failure Friday, was unable to sell all of the debt it offered at an auction.

More

The tight liquidity situation is leading to some calls from Chinese banks for the People's Bank of China to inject more cash into the market by lowering the share of deposits banks are required to set aside against financial trouble. The measure is known as the reserve-requirement ratio, or RRR. "Internally, we're hoping for an RRR cut by the end of Wednesday," said a senior executive at one of China's top four state-owned banks.

The central bank didn't respond to a request for comment.

Some analysts, including Xu Gao at Everbright Securities Co.6017882.44% in Beijing, expect the PBOC to take measures to ease the liquidity crunch in the coming weeks. The central bank last cut its reserve-requirement ratio in May 2012.

ENLARGE

A currency exchange in Hong Kong. Economists cite less foreign money flowing into China as a reason for a cash squeeze.
Agence France-Presse/Getty Images

The concern about a credit crunch comes at a time when Chinese officials also are trying to combat the opposite: a credit binge that dates from the stimulus spending of 2009. The two are linked, analysts say. By trying to rein in the long-term credit surge, the PBOC may have produced a short-term credit crunch. But any big intervention by the PBOC—which, unlike the central banks in the West, isn't independent of the nation's political leaders—would risk sending a signal that China's top leaders would rather sacrifice their goal of keeping a lid on credit growth in favor of pumping up domestic economic growth.

That would run counter to the remarks made by Chinese leaders in recent months. Premier Li Keqiang, for instance, has indicated that Beijing is reluctant to change its monetary- and fiscal-policy stance to counter a slowdown while pledging to press ahead with changes that could make the country's growth more sustainable.

"Right now, an RRR cut would be very controversial, because that would signal a change in macroeconomic policy," said Li Wei, an economist with Standard Chartered in Shanghai.

Traders and economists cite a sudden reduction in foreign capital inflows—the result of China's recent crackdown on speculative money flows and of a slowing economy—as one of the main reasons for the cash squeeze. That is because companies aren't converting as much foreign currency into China's currency, the yuan, resulting in less yuan funds flowing into the economy. Adding to the shortage of funds is additional demand for cash so that banks can meet the obligations of repaying investors who hold some high-yielding investment products sold by banks, known as wealth-management products.

On Monday, China's benchmark seven-day bond-repurchase rate reached 6.85% on a weighted-average basis, near its highest level since China started compiling the rate in 2006. The highest level, at 6.9%, was reached Friday.

So far, China's central bank has appeared to be more willing to keep what it calls a "prudent" monetary-policy stance than to carry out operations aimed at easing banks' funding constraints. As part of the prudent monetary stance, the PBOC has been trying to stem a surge in credit that could produce a wave of bad debts and financial failures.

Total social financing, China's widest measure of credit that includes both bank loans and credit created outside formal banking channels, fell by about one-third to 1.19 trillion yuan in May from April, the second month of substantial decline. But the central bank still has a way to go to curb overall lending: In the first five months of 2013, total social financing was up 52% from 2012.

A commentary published on Monday by China's Financial Times, a newspaper backed by the PBOC, dismissed the prospect of a liquidity crisis in China's money market but said some individual banks suffered funding problems because they had relied heavily on borrowing short-term funds in the interbank market and exceeded regulatory limits on lending. The article also said banks should sort out the funding problems on their own and shouldn't count on the PBOC to step in to provide liquidity.

On Tuesday, the PBOC sold two billion yuan worth of 91-day bills the next day. The bill sale means that the central bank drained two billion yuan of liquidity from the money market, a negligible amount that would hardly sway the market but a signal China's policy makers aren't yet ready to loosen the grip on money supply. Last week, the PBOC injected a net 92 billion yuan into the market, a small amount relative to Chinese banks' funding needs.Only 32 billion yuan in central-bank bills and other notes are due to mature this week, meaning the PBOC would have to inject extra liquidity if it wants to improve the funding situation significantly.

Said Wang Tao, an economist at UBS AG: "Through the events over the past week, we think the PBOC has made it clear that overly rapid credit expansion would not be accommodated, and that the PBOC still focuses more on the quantity of credit and money supply rather than on short-term interest rates."

"In other words," Ms. Wang said, "if banks let credit growth go too fast, the PBOC doesn't mind the spike in interbank rates in order to rein them in." The recent cash crunch may lead to banks trimming their credit exposure and managing liquidity more prudently, she added, even though "there is a small risk that this could lead to a credit crunch in the short run."

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.